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JC Penney - Maximum Pessimism?
Posted by: Jianing (IP Logged)
Date: March 27, 2013 10:05AM
If you go to Yahoo Finance and search for headlines of J.C. Penney (JCP), chances are you will not see many positive headlines. In fact, you probably don't even need to go to Yahoo Finance — the popular media and Wall Street analysts have been nothing but negative about the outlook for J.C. Penney. Below are a few quotes:
"An analyst at BMO Capital Markets downgraded JCP from marketperform to underperform, and said at this rate the company may go bankrupt next year. The company's stock is now at less than 40% of its 52-week high, which was a year ago tomorrow."
"J.C. Penney has been a train wreck whose comeback always seems just around the next earnings corner, but investors are beginning to doubt that CEO Ron Johnson can weave the same magic that he did at Apple." — CNBC
"J.C. Penney is doing everything short of walking into your living room and executing short trades for you. They're screaming from rooftops in their last annual filing that things aren't going as planned. The stock chart looks like a slalom route for the '98 Nagano men's Olympic downhill team." — Motley Fool
"The company is stuck on a mezozoic era branding problem, and has failed to make massive, paradigm shifting changes to their business. They are not focusing enough on online sales and younger generations, all the while seriously burning through cash." — Seeking Alpha
Further evidences of pessimism include a 44% short interest in J.C. Penney's stock and only one "buy" rating from analysts covering J.C. Penney. So the pessimism is obvious, but the question is, does this represent "rational herding" (i.e. JCP is a value trap) or does this represent a buying-at-maximum-pessimism opportunity? There are a few apparent and seemingly compelling arguments for being bearish on JCP:
1. The turnaround has not been working. Sales are down 25% year over year and 31% for the most recent quarter. The loss is even more horrendous and profit margin is deteriorating.
2. J.C. Penny has been losing old customers and not been able to attract enough new customers. The pricing strategy in 2012 isolated itself from its loyal old customers and they may never come back.
3. A major insider (Vornado) has lost faith in J.C. Penney by dumping 40% of its shares.
4. J.C. Penney will be burning cash at an accelerated rate and may not exist in a few years.
5. Sales will most likely continue to go down unless Johnson is fired.
6. The Martha Stewart Store may not work out.
7. The shops are not enough to save J.C. Penney.
8. J.C. Penney's new executives are not even living in Texas. They are not involved enough in the day-to-day operation.
I think these are all valid points, but I do have a few questions to the investors who share the above bearish view:
1. Are the bad news reflected in JC Penney's stock price?
2. Does the other side of the trade-namely the buyers of JC Penneys' stock, know about those negative views?
3. Are you subject to the availability bias, the confirmation bias, the endowment bias and the social proof bias?
4. Have you done a thorough research (not just visiting stores) and come up with risk/reward analysis?
5. Did Ron Johnson and the Penney Board ever say the turnaround will be done in 2013 and did he mention that sales and profits will be down for a while?
If you read "Celebration of Fools" by Bill Hare, you will find out that the problem with J.C. Penney did not start with Ron Johnson. Early problems with J.C. Penney emerged at the late years when Bill Howell was still Penney's CEO. Bill Howell was not known for any particular stellar accomplishment, unlike the previous Penney's CEOs. He was charismatic politically with an executive image. He always chose his publicized appearance with great care, favoring prestige events like serving on a While House Blue ribbon panel. He started paying a lot of attention to Wall Street and under his reign, J.C. Penny became overly bureaucratic. Jim Osterreicher, the CEO after Bill Howell, was unable to make important decisions until last minutes and not communicating what he wanted exactly. Osterreicher also made bad acquisitions such as Eckerd. Neither Allen Questrom nor Mike Ullman made things better for J.C. Penney. Mike Ullman initiated massive off-mall stores investments which proved to be unsuccessful.
Continued struggle since the 1990s made it clear that J.C. Penney needed a change, to quote Mil Batten, J.C. Penney's legendary CEO, "Change, of course, is the only constant, the future never assured. So to not plan for change and not invest in the future would be crazy, no matter what Wall Street says." This is why I believe Bill Ackman brought in Ron Johnson. J.C. Penney needed a change, and not a small one.
The changes Johnson made have been discouraging so far, to say the best. However, there is some hope. First, Johnson made a few big mistakes, but he had realized that he screwed up and he had taken steps to correct those mistakes. Admitting mistakes and learning from them is not the easiest thing in the world. Second, J.C. Penney only installed a very small portion of shops so far. The result of Joe Fresh and the like is still to be seen, but it is hard to imagine those shops will do worse than their current lineups. Third, one reason sales and margins were down dramatically last year is that Johnson's team got rid of a lot of old obsolete inventories. Inventories went down by $600 million during 2012 and most likely the majority of them were sold below cost. This is unlikely to happen in 2013. Therefore, I expect at least better margins for 2013.
One of my favorite and most respected writers and investors on GuruFocus, The Science of Hitting, has done a masterful job of analyzing J.C. Penney from a consumer's perspective. His article is a good read (at least for the sake of disconfirming evidence) for JCP bears.
As far as valuation is concerned, I calculated for the liquidation value and came up with a range of $13 to $16, assuming a 33% discount on inventory at lower cost or market as shown on the balance sheet, and if you mark up 40% of J.C. Penney's property value by 50% (Penney owns a little more than 40% of the approximately 1,100 stores). There are other assumptions regarding other assets such as deferred taxes assets but they are not material. I think Whitney Tilson and Bill Ackman have also calculated the down side risk for J.C. Penney as well. The point is, at less than $15 per share, the market has pretty much priced in the worst for J.C. Penney, and it looks that at this point the risk/reward ratio favors the long side of the stock. Of course I could be very wrong about JC Penney but if that's the case, I will be grateful for the learning oppportunity.
I also want to share with you the stories of a few most recent notorious value traps:
Current Price as of 3/26/2013: 3.30
Current Price as of 3/26/2013:23.64
Current Price as of 3/26/2013:14.46
Current Price as of 3/26/2013:27.60
Current Price as of 3/26/2013: 3.36
Let me end with one of my favorite quotes:
"The time of maximum pessimism is the best time to buy, and the time of maximum optimism is the best time to sell." — Sir John Templeton
With that, I welcome any criticism and further discussion.
Disclosure: Long JCP and long JCP Call Options[/size]
JC Penney - Maximum Pessimism
Posted by: w1omega (IP Logged)
Date: March 27, 2013 04:13PM
I don't disagree with any particular point, but I fear JCP might end up becoming Ron Johnson's version of Bugsy and Las Vegas: Bugsy's vision of Vegas eventually came true, but the success, unfortunately, came too slow for him. RJ's plan seems to make sense on paper, but the great Peter Lynch said wait 'til investing in a turnaround has turned. Buffett has a similar saying as well. This obvious would lessen your return, but you are also taking on a lot less risk as well. Incidentally, Buffett, although cheers for JCP's success, said it has a tough road ahead.
Liquidation value is one of those things with a big range of possibilities IMO. In a bankruptcy preceding, I doubt current shareholders will get even $9 per share or even $5 for that matter. Of course, situation could change if there's a white knight or white squire, hence the huge range of possibilities. I remember reading about Kmart bankruptcy preceding and its properties sold for ridiculously low amounts. I think a huge Kmart store sold for $600k in 2002 or whenever it was.
Most companies have some maneuvering they can do by selling assets, etc. I believe JCP's mgmt when they said they have some flexibility as well. But since they never quantified in terms of how many years will this flexibility provide them for the turnaround, investors are taking on unknown but probably enormous amount of risk.
Out of the stocks you listed, I know at least RIMM went below BV. I think RIMM went as low as 0.4 times BV. To me, Rimm was a bargain around $7 to $9 bc of $2B cash, no debt, market share in emerging markets, and patents. It's apples and oranges, I know, but JCP doesn't seem as a big a bargain as RIMM at the bottom.
I'm curious. Why did you add 50% to the properties values to the 39% of the stores JCP owns. Where did you get that 50% number? Appreciate your article BTW.
Any thoughts about whether the LT leases are worth anything?
JC Penney - Maximum Pessimism
Posted by: Ning Jia (IP Logged)
Date: March 27, 2013 06:39PM
Great and very insight comments, thanks so much.
With regard to the 50% mark up, I took a look at the Statement of Cash Flows and went back for a couple of years, summed up all the proceeds from sale of assets from the cash flow from investing section and also summed up all the gains on sales of assets from the cash flow from operating section. I only went back to 2008 but if you divided total gains on sale of assets by total proceeds from sale of assets, you get pretty close to 50%. Of course not all of those assets are properties but I think that is a good enough proxy.
I certainly think the LT leases are worth something but I don't know how much they are worth and it is not within my circle of competence to come up with a range.
I heard Buffett on CNBC when he told Becky Quick that JC Penney has a very tough road ahead and I am very well aware of the fact that turnarounds usually don't turn. That's why I usually shy away from turnarounds but this one in my opinion offers a better risk/rewards ratio. Also more than half of my exposure to JCP is through long call options.
And to address the value traps I listed, I actually did a mini study on them. All 5 of them have a P/B ratio below 1 at their lowest point with HPQ being the highest (0.994) and RSH being the lowest (0.287). Their P/S ranged from 0.04 (RSH) to 0.36 (FSLR) at the low point. I agree RIMM looked like a bargain at $7 but I couldn't tell whether Blackberry could survive or not at all. Technology is different from retail. When I started working, half of my colleagues were using Blackberry. Now, only 1 of them still has a Blackberry and he's switching to either iPhone or Samsung soon. People will still shop at department stores even though you can buy almost everything online. You can't replace the in-store experience with online shopping and customers base their decisions on price and quality and I think price and quality are exactly what JC Penney is focusing on now.
Thanks again for the comment. Like I mentioned in the article, I could be dead wrong on JC Penney and it will be a valuable lesson if that's the case.
JC Penney - Maximum Pessimism
Posted by: swnyc2 (IP Logged)
Date: March 27, 2013 08:33PM
Thank you for your thoughts. I agree that JCP is priced to fail and that any good news will result in a substantial increase in the stock price because of the large short interest. My estimate of JCP's liquidation value is $10-$12 at the end of this year, if JCP sales do not increase - not so far from your current estimate.
JCP's upside is much greater than its downside. If Ron Johnson's idea of essentially renting out his inexpensive retail space to private brands that want to quickly expand works, the stock could easily be worth more than $40 per share (which is what it was trading for 1 year ago). So with a $5 per share downside and a $25+ per share upside, the market is essentially saying that there is more than an 80% chance of bankruptcy. I just don't think that is nearly so likely to happen. But, I could believe the risk is 10-20%. Clearly this is a risky stock that should not comprise a major portion of any investor's portfolio, but I still think it's a good buy at $15 per share in modest amounts.
I am long JCP and purchased more this week to take advantage of its recent low price. This strategy has worked well for me recently with other beaten down stocks such as HPQ, SPLS, and MRVL. It will work for JCP too. Why? Because in addition to the market being especially pessimistic in the long term, there are a few short term catalysts that will lead to an increase in the stock price. One catalyst is the resolution of the lawsuit with Macy's, which I expect will happen within the next few weeks. No matter what the outcome, it will be positive for JCP. Mr. Market hates uncertainty even more than a certain bad outcome. It will be in the best interests of both parties to negotiate a settlement, rather than rely on an uncertain decision by the judge.
Another catalyst, will be comparable sales numbers. In the upcoming quarters, the prior year comparisons will be quite low. The increase in the number of shops, the decrease of inventory, and the decrease in expenses will lead to better yoy revenue and earnings than what the market expects. (The market expects continued sales losses of 20-30%.)
I also have enjoyed Science of Hitting's prior analyses of JCP very much. I am looking forward to his comments on their recently released annual report. However, in my mind, not much has changed in the past quarter, Sure, sales are poor. But, I believe that the new JCP retail experience will appeal to a certain customer, likely not the customer that used to shop at the old JCP. Many things that are worthwhile in life take longer than one would normally expect. This is I think just one more example of that and how good value investors need to be patient.
JC Penney - Maximum Pessimism
Posted by: The Science of Hitting (IP Logged)
Date: March 27, 2013 08:40PM
Quick note on Kmart - in their 10-K filed for the year end January 2001, they owned 133 of their 2100+ stores - or right around 6% of their total store base; the comparable figure for JCP at this point in time is just under 40%. I agree with you on the uncertainty around liquidation value, but thought that was worth pointing out.
JC Penney - Maximum Pessimism
Posted by: shaved_head_and_balls (IP Logged)
Date: March 27, 2013 11:53PM
Maximum pessimism will be when JCP stock is under $9 per share, just like in the year 2000.
JC Penney - Maximum Pessimism
Posted by: buynhold (IP Logged)
Date: March 28, 2013 04:58AM
Retailing is hard. Retail turnarounds are very very hard. Just look at Carrefour, which was supposedly an easy turnaround under Lars Olofsson with a succesful pilot of the new store format.
None of the writeups on JCP have convinced me that it could be anything beyond a cigar butt. I don't see a moat; anything Ron Johnson does at JCP, if successful, can be replicated by some other stores in the medium to long-term, no? It's not like a contract with Martha Stewart can be kept exclusive.
So, in a nutshell, if JCP's turnaround is successful, can it retain its earnings power longer term? How?
JC Penney - Maximum Pessimism
Posted by: Ning Jia (IP Logged)
Date: March 28, 2013 09:25AM
Swnyc2- Thanks for your great comments. I agree any sort of good news can trigger short covering and short-term upward price movement but we are in for long term and like you said, this one maybe another example of how good value investors need to be patient. Only time will tell whether our analysis is right or wrong. Most people are still skeptical and it does take courage to go contrarian on this one.
Science- Thanks for the note.
Shaved-Although Penney was also in trouble during 2000, things are a little different. Jim Oesterreicher was the CEO back then and he was possibly the worst CEO in Penney's history. JC Penney was using too much leverage and it poorly acquired the drug store business (Eckerd in 1996) and that dragged on for years. But I won't rule out any possibility JCP can fall below 10. Thanks for commenting.
Buynhold: Good point. JC Penney may well be just a cigar butt now. The question is, is there a good puff left? Some value investors think so and some value investors think otherwise. It's a matter of opinion. I don't know whether the turnaround will work or not and other retailers can certainly copy what Penney did if the shop format ultimately becomes successful. My point in the article is even if the turnaround is not successful (JC Penney has been in the turnaround mode in while, way before Johnson) the price of JCP looks attractive as it seems to reflect too much pessimism. Both Mike Ullman and Allen Questrom were also engaged in turnaround efforts albeit not as dramatic as Johnson and you see JCP's stock ranged between low teens to 80. And as far as moat, I would say JC Penney's legacy off mall stores, especially in smaller cities and towns are still dominating local markets and there're 424 of them with 19 million square feet. Penney is also leasing the non-owned retail space at $4/sf, which is almost ridiculously cheap. In spite of all the troubles, it still has enormous sourcing power and bargaining power with vendors.
JC Penney - Maximum Pessimism
Posted by: Cornelius Chan (IP Logged)
Date: March 30, 2013 03:04AM
That list of so-called value traps is interesting. I pretty much have egg on my face still from purchasing NOK too high. A good learning experience though.
I know next to nothing about the U.S.A. general merchandise retailing industry, so my comments are next to worthless... that being said, is anyone surprised at the stock tanking since 2012 annual results? -4.49 EPS? I mean, this result is astronomically awful if anyone was looking for a turnaround. Add onto that the fact that earnings have been falling since 2007 with not much prospect of an immediate turnaround and before you know it... POW!! ... Mr. Market has priced JCP at $5 per share. Then we can start talking liquidation value. Too early yet.
This company's financials do remind me of NOK come to think of it. Steadily declining revenue, earnings per share, return on equity, assets both current and total and operating cash flow. The only question is, which company is more unknowable? NOK or JCP...
Better to stick to the better companies... like a Dillard's, Nordstrom or Macy's.
JC Penney - Maximum Pessimism
Posted by: invisibleperson (IP Logged)
Date: April 2, 2013 07:50AM
Nice article and I appreciate the humbleness. My opinions are below:
I have also bought JCP LEAPS when the stock was at around $18. The LEAPS have more than halved since then and it hurts. Hopefully, 1 year and 9 months is enough time for significant changes to happen and for the market to appreciate them. It's a judgement of chances, though I do think the LEAPS are very cheap at the current price.
In terms of whether "maximum pessimism" has been reached, though it's hard (if not impossible) to predict stock bottoms, I have been thinking the same thing for the last couple of months. It reminds me of the news sentiment when RIM was around 7 (I abstained from buying because there seemed to be too much uncertainty regarding new product sales). Lots of talk about bankruptcy and Ron Johnson's mistakes. From the valuations I've seen (esp. by Ackman and Tilson as mentioned by you), it does appear close to liquidation value, though it begs the question how long it would take for a billion-dollar company like JCP to liquidate.
I have slowly admitted that at least half of the pricing strategy was a mistake (wished I had seen Davidovitz talk before). Couponing was so ingrained into the JCPenney shopper's mindset. I have watched numerous haul videos with the shopper starting out with each clothing about how she made a good buy at the discount. In hindsight I think that removing the anchoring effect of coupons and most of the discounts that gave a reason for shoppers to buy more clothes was a mistake in psychology. On the other side, I think setting more realistic and stable prices to appease vendors and reduce tagging work and removing excess sales that made them look meaningless were still good decisions.
I think the changes in JCP culture have also had a large impact. From what I've read, JCPenney's consumers tended to lean towards middle-age (families) and the elderly with conservative dress style. In comes Ron Johnson with sleek & forward-looking vision implemented at a speed abnormal for retail. Many of the negative comments I have read are from older women who miss their coupons/clothing they're used to/can't stand all the changes (see [www.mallseeker.com] or old JCPenney FB page - note the anger of missing St. John's Bay [size=13px; line-height: 1.22]). At the same time, I'm getting some vibes of fashionistas - the early adopters - liking of the changes. I say this with reservation because it is easy to become biased if you want the stock to do well.
[/size]http://www.youtube.com/watch?v=PpNcDXvzK-U - [size=13px; line-height: 1.22]_[/size]"Used to shop. Clothes got expensive. In the last year clothes have really gotten better. I'm kind of startng to like it again"
[www.youtube.com] [size=13px; line-height: 1.22] [/size] [size=13px; line-height: 1.22]_[/size]"I just did not have any idea the things I could find at JCPenney.Kind of like sears and parents and grandparents used to bring you there"
[www.youtube.com] "Check them out"
[www.youtube.com] "amazed at prices & quality"
Comments at [size=13px; line-height: 1.22]_[/size]http://dappered.com/2013/03/is-jc-penney-doomed/
[brokecitystyle.com] "Imagine my surprise when one of the most elite fashion houses started a collection for none other than JC Penney." [size=13px; line-height: 1.22]
[/size]Male Fashion Reddit [www.reddit.com] " [size=13px; line-height: 1.22]"
My opinion: there's a switch happening. Older people not content with the changes are getting (or mostly have gotten) out and we're at the starting phase of younger fashion-conscious consumers getting in (which may take quite some time).
Keeping things in perspective
As disappointed I was in how negative sales got, I think one needs to look at the bigger picture and try keep things in perspective.
- the stock is close to liquidation value
- they had already $600 millions of savings this year and are cutting costs really aggressively, as much as former employees hate them for it.
- liquidity to carry out changes in the medium-turn with revolver
- good management, despite past mistakes. Ron Johnson has a great consumer focus and is bringing in like-minded people like Michael Kramer, Nick Wooster, Ben Fay from well-known companies such as Apple and Abercrombie & Fitch. Ken Hannah appears sensible in financial management and has background (Boeing, GE) to give me some confidence in his abilities.
- management has been open in plans and has admitted mistakes and adapted. The return of coupons & discounts, St. John's Bay clothing, the words "sales" and "clearance" in 2012, the introduction of MSRP labels and removal of month-long value theme come to mind.
- Bill Ackman is in and staying. Stock trades at 40% discount to his ~$25 average buy price. His presence grants management time, similar to private-equity, to make big changes without being oustered half-way.
- vendors, in my opinion, are impressive. High-class products at reasonable prices (possibly still too expensive for JCP consumer). Good looking clothes and designs. Vendors like Michael Graves, Terrence Conran, Duro Oluwu and Jonathan Adler have an eye to detail and unusual level of desire to make something the customer will love to have. When I think about Disney, Martha Stewart (if able to sell products), Oluwu or Georgina Chapman, I think these are hard-to-get brands most retailers would pay a lot for to have in their stores.
- in the long run, targeting the younger generation (as much as RJ says JCPenney is for everyone) is a good thing. Hate to be captain obvious, but older people do not live on forever. Selling clothes like those of Fast Fashion stores (with corresponding higher margins) instead of mostly undifferentiated traditional clothes that have accompanied a decline in sales since 2007 also does not sound like a bad idea. I admire Nordstrom's clothes, atmosphere, forward-looking use of tech and JCPenney seems to be moving in that direction.
- strategy is differentiated and geared to making a great customer experience. The shops provide a way for vendors to show their brands and for consumers to orient and pick and choose better (app approach). I'm happy to hear Target is discontinuing their shops for now. One negative is that products are no longer sorted by type (shirts, pants, etc.), which could be confusing. The ideas for integration with technology such as WiFi (which was needed), mobile payment & libbies & iPads are forward-looking and make sense to me.
- MSRP tags, and return to some coupons and sales brings back the "anchoring effect" (though the higher price stickers put on top of old tags does not seem well-thought through to me and left me nervous.)
- consumers who hated the changes the most have left already. Less people left that could leave.
- everyone seems to be negative. I looked at Corner of Fairfax & Berkshire and even they are negative (if value investors are negative, is that a good thing?).
- retail turnarounds are notoriously difficult to accomplish. Buffet's quote comes to mind: " [color=#7d7d7d; font-family: Palatino, 'Times New Roman', serif; font-size: 15px; font-style: italic; line-height: 20.015625px; text-align: justify]How many retailers have really sunk, and then come back? Not many. I can’t think of any. Don’t bet against the best. Costco is working on a 10-11% gross margin that is better than the Wal-Mart’s and Sams’. In comparison, department stores have 35% gross margins.[/color] [size=13px; line-height: 1.22]" [/size]http://variantperceptions.wordpress.com/2012/12/04/buffett-on-the-imperfect-turnaround/
A great investor like Eddie Lampert has been working on it for years (though admittedly with more deteriorated stores and difficulties integrating the KMart and Sears merger)
- it took two years for people to really start visiting Apple Stores according to RJ. How long will it take for JCP?
- Steve Roth has sold 40% of his stake at what I would consider a firesale price. I don't buy Ken Hannah's argument that there was too much fuss on earnings calls. Why not just sell everything then?
- construction is reducing space for sales & impedes customers in short-term
- difficult to gauge how customers will respond. Very subjective.
- retail is sensitive to the economy and consumer sentiment. JCPenney could be hit hard if the economy turns again and it has been 4 years since last recession.
- they are competing with highly competent management at May's, Target, Nordstrom & Walmart's. Though I think retail hasn't evolved much, these people are definitely not resting on their laurels.
- management is going as fast as their cash allows but this Silicon-Valley approach of making mistakes quickly could also backfire when something happens yet again to alienate customers (e.g. not enough cash registers)
- Martha Stewart's seems like a glaring mistake. Though Ron Johnson couldn't look at the Macy's contract, he relied on Martha Stewart's lawyers' advice on a loophole (Martha allowed to have own shops), which turned out not to be a loophole (the wording of contract indicated selling in another department store was not allowed). He also gave generous terms for this deal. I wonder if Ron Johnson was too positive. See [www.nytimes.com]
I'm optimistic in the long run but I wouldn't have a clue how long it will take (did I make a mistake buying the LEAPS?). We've just had a string of bad news. Mean reversion dictates things are likely going to turn. I also think the management's determination for creating a great customer experience and introducing prized brands should not be underestimated.